Here’s what’s behind America’s renewed mania for home renovation

The Golden, Colo., ranch home Anne and Eric Drobny live in with their children was supposed to be a five-year house. But five years turned into eight, and things are getting tight.

“My kids are 10 and 13, and they’re only getting bigger,” said Anne Drobny. “It’s important to us, as the kids get older, that they want to hang out here with their friends. Right now, with the layout, they couldn’t do that.”

They considered moving, but houses in their Applewood neighborhood can go off the market in hours; at one point, they agreed that if Anne liked a house, she could make an offer without him seeing it. Now, they’re remodeling instead, and may use a home equity line of credit to pay for the expanded kitchen, laundry room and music room they want.

Courtesy Anne Drobny

Anne Drobny with her children in the family's Golden, Colo., home.

Stories like theirs are increasingly common. Thin housing inventory has contributed to a spike in remodeling as buyers pour money into their current homes instead of moving — often using home equity to do it.

Realtors talk of clients who have called contractors after being outbid multiple times. Others report would-be buyers who back off after learning they can’t afford to stay in their neighborhoods. Some market watchers say expected increases in mortgage rates could induce even more to stay in place so they can keep low fixed-rate payments.

When people stay put, it can reverberate through the housing market, making it harder for first-time buyers to get started — and, some say, highlighting a need for more construction. Without enough new homes, said Seattle real-estate agent Sam DeBord, the market could be stuck in “a self-reinforcing cycle.”

‘There’s not a lot of quality inventory out there’

There was 4.5 months of housing inventory for sale in the U.S. in March, according to the National Association of Realtors, meaning it would take that long for every house on the market to sell at the current pace of sales. Higher inventories benefit buyers, while lower ones benefit sellers; a market is generally considered balanced when there’s five or six months of inventory.

The main reason for the shortage, according to National Association of Realtors chief economist Lawrence Yun, is that there hasn’t been enough new-home inventory added over the past decade: Homebuilding contracted after the last housing crash, and is still catching up to current demand.

Yun believes the shortage won’t improve soon; if so, experts say, even more potential buyers could be driven out of the market.

With mortgage rates expected to rise in the coming years, some may not move for another reason: They’ll want to keep their 30-year fixed-rate mortgages in the 3.5% range, said Svenja Gudell, chief economist for Zillow. The Mortgage Bankers Association predicts rates on 30-year fixed-rate mortgages will rise to an average of 4.7% in 2017 and 5.2% in 2018.

Meanwhile, experts say the homes currently on the market often aren’t what people are looking for: move-in ready homes that don’t need much work.

“There’s not a lot of quality inventory out there, and when it comes on the market, it goes very quickly,” said Geoff Horen, chief executive of The Lifestyle Group, an Indianapolis residential remodeling company. So homeowners face a choice: Buy a property that needs work, build, or put money into their current home.

The Lifestyle Group

Examples of home improvements completed by The Lifestyle Group, an Indianapolis remodeling company.

“People get discouraged,” said Matt Silver, president-elect of the Chicago Association of Realtors. “Because there is such low inventory, people are like, ‘OK, that’s what we’re going to do, rehab and update, and when the market is more free-flowing, then we will go and try to find something,’” he said.

Meanwhile, home-improvement spending is expected to reach its highest level in a decade by early next year, according to Harvard University’s Joint Center for Housing Studies. Remodeling spending is expected to reach $325 billion by early 2017, according to the university’s Leading Indicator of Remodeling Activity.

Remodelers say homeowners are doing more discretionary projects — upgraded kitchens and baths, for example, with higher-end finishes — many which were put off after the housing bust.

“They’re not afraid to pick the nicer tile,” Horen said. “Once someone looks around and can’t find what they want…and decide to stay and invest the money, they are probably doing it with a different mind-set. They might be inclined to spend more.”

Cash-out refinancing activity is at precrash levels

A fundamental reason homeowners see remodeling as an attractive alternative to moving: More are now eligible to tap their home’s equity to pay for improvements.

When home prices plummeted in the last housing crash, homeowners lost trillions of dollars in home equity. Some owed more than their homes were worth. Home-equity lending naturally waned.

Years later, it’s a different story. By the end of last year, 91.5% of residential properties with mortgages had equity, according to property information company CoreLogic. Home equity has increased by $6 trillion since mid-2011, and more than 60 million homes have at least 25% equity.

Patricia Sherman, of Plymouth, Mass., near Cape Cod, is using a cash-out refinancing to pay for a $74,000 upgrade, remodeling her kitchen — she’s trading in “ugly white cabinets” for cherry wood and installing granite countertops — renovating three bathrooms and finishing the basement.

Sherman bought the house in 2010 for $260,000; it’s now worth $335,000, before the renovations. By refinancing, she will also get a lower interest rate.

The share of cash-out refinancing activity — in a cash-out refinance, the new mortgage amount is higher than the unpaid principal balance of the old one, putting cash in the borrower’s pocket at closing — has reached levels not seen since before the housing crash.

In the fourth quarter of 2015, 41% of first-lien refinances were cash-out transactions. according to Black Knight Financial Services, up from 34%, 29% and 18% in the fourth quarters of 2014, 2013 and 2012, respectively. In the third quarter, 42% were cash-out transactions, the highest on record since 2008. (Black Knight defines a cash-out refinance as one in which the amount is at least 5% greater than the balance of the original mortgage.)

Courtesy Patricia Sherman

Patricia Sherman with her daughter in their Plymouth, Mass., home.

Lending via home-equity lines of credit is also growing. (With a “Heloc,” a homeowner has a credit line they can draw from when they need it, and the loan is secured by the property; there’s typically a drawdown period of 5 to 10 years, during which the borrower need only make interest payments, followed by a repayment period, requiring payments to principal.)

At 1.3 million, Heloc approvals in 2015 were at their highest since 2008, and more than double the volume of three years ago, according to CoreLogic — though less than half the volume seen in 2006.

A couple gets back into the market — and gets quickly outbid

Deciding whether to remodel or move isn’t always easy. Some homeowners find themselves moving between the options as they investigate further.

“The thing that people are weighing is: ‘What can I get for my money if I go the new construction path?’ That, oftentimes, is bringing back clients around to the remodel idea,” said Horen. “They may be in a $350,000 house, but to get what they want, they may need to spend $500,000 or $550,000 new. Then, putting $100,000 into the house looks attractive again.”

But not everyone has a sense of what projects typically cost, and Horen says some are surprised to learn they’d have to spend more than they assumed.

Tight inventory and high prices led Nate Heffter and his wife, Abby Wong-Heffter, to consider renovating their 1,000 square foot home in Seattle. They wanted to add a bedroom and bathroom and extend their kitchen to make more room for themselves and their two kids. They hired an architect to draw up plans, which included tearing off the roof and adding a second floor.

But then came the price tag: $700,000. That, plus the cost of temporary living arrangements while the work was being done, might buy them a lot in a better neighborhood.

“Remodeling a house that we already own has disadvantages to it, including the length of time it takes to actualize that, as well as vacating the house…versus the perceived ease of moving into another house,” said Heffter.

While they haven’t ruled out remodeling, they are now back on the market for a new home. They’ve already made an offer on one — and were outbid.

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